As we enter the fourth quarter in the markets, we do so on the back of a policy shift by the Federal Reserve. September turned out to be a strong month for US equities as the S&P advanced by about 2.5%. The Nasdaq also advanced but the tech-heavy index is still sitting below its highs made in July as uncertainty remains, especially with the looming elections. The broad advancement by stocks was spurred by changes in Fed policy as Chairman Powell announced a 50 basis point (0.5%) interest rate cut and guided for an additional 50bp cut before year-end. The Fed felt that inflation had cooled enough to allow them to focus on the other aspect of their mandate, full employment. Price stability and full employment for the American worker are the two directives given to the Federal Reserve. Powell repeatedly described the policy move as a “recalibration,” noting “slowed” job gains and “confidence that inflation is moving sustainably towards 2%.” This normalization of Fed policy is in contrast to the aggressive rate hikes we saw over the past few years to beat back inflation. A battle that has largely been successful. The markets are now predicting a further 50bp cut (as hinted by the Fed) this year, then a 1% cut in 2025, and a further 50bp cut in 2026. At that point the Fed believes they will have reached “neutrality,” meaning interest rates are neither accelerating nor restricting the economy.
A move toward neutrality is also known as policy normalization. And now that normalization has begun with more rate cuts coming, this should bode well for consumers as borrowing rates come down and access to credit increases. The Fed is in a difficult position because easing rates too aggressively to boost the economy can backfire in two different ways. One is that it can reignite inflation; and secondly it can actually decrease confidence by stoking recession fears. Investors will think something bad must be in the tea leaves if the Fed is trying to juice the economy. This is most likely why in response to the rate decision markets saw mixed price action. Nevertheless, this policy action should bode well for both stocks and bonds giving the steady growth of the economy and lower inflation readings.
A key question for investors is when will industry embrace that we are in an economic expansion and position for higher demand? For the most part, industries other than tech are not beefing up their production capabilities out of a belief that the US consumer is tapped out, or that restrictive tariffs are soon coming. However, if demand does indeed pick up there could be a rush to upgrade production which could drive commodity and material prices higher. So far, commodity prices have remained relatively stable, but we have seen a notable uptick in the performance of industrial and material stock prices. Perhaps there is already a change afoot. This will be something we will be keeping an eye on in the near future.